Cash Flow Coverage Ratio is a KPI used to measure the number of times the financial obligations of a company are covered by its earnings. It is calculated by dividing operating cash flows by total current debt. Operating cash flows can be found in the statement of cash flows. Using the direct method, the operating cash flows can be ascertained by taking into account cash inflows and outflows that are directly related to the operations of the company. This includes cash receipts from customers, cash paid to suppliers and employees, interest paid, and income taxes paid as related to operations.
Cash flow coverage ratios should be greater than one. Ratios of one or greater indicate the business has enough cash flow from operations prior to taxes to cover its debt obligations. This ratio is often used by financial institutions to determine the creditworthiness of a company. A company with a larger cash flow coverage ratio indicates it has less dependence on debt and therefore could have more opportunities for expansion without additional requirements imposed upon them as part of debt agreements.
If the cash flow coverage ratio is less than one, this indicates the business does not have enough cash flow from operations to currently cover its debt obligations. A company in this situation should look for ways to improve its cash flow coverage ratio. Improvements to the cash flow coverage ratio can be made by decreasing your company’s draw, reducing G&A expenses, or paying off and retiring existing debt.
It is important to track this ratio and know how it is trending. By knowing the important KPIs financial institutions review, the better prepared your company will be when negotiating for important financing opportunities. Contact Porte Brown to obtain more information on selecting the best KPIs for your organization.
Get in touch today and find out how we can help you meet your objectives.
